Why Sklansky's idea should not work

[Foghatlive]

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Since the market is not static and in fact has shown a propensity to rise 10% a year on average...

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I've heard this stat many times but whenever I do a bit of research, I arrive at a number much lower.

In the year 1900 the Dow was ~60; in 2000, ~10,000. I think 100 years would qualify as "long term."

According to my compounding calculator the interest rate on 60 over 100 years that would amount to 10,000 is 5.25.

I also did the calculation for the last 10 years in which the market went from 8000 to 13,000. It comes out to ~5%.

The morale is that buying an index fund gets you about the same as a CD, but puts your principle at risk.

Dow Price History

[haakee]

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According to my compounding calculator the interest rate on 60 over 100 years that would amount to 10,000 is 5.25.


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You failed to include dividends. Until recently dividends for the Dow tended to exceed 3% annually.

[Foghatlive]

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According to my compounding calculator the interest rate on 60 over 100 years that would amount to 10,000 is 5.25.


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You failed to include dividends. Until recently dividends for the Dow tended to exceed 3% annually.

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When you're right, you're right.

I don't how I would compute the return w/ divs, as different companies comprised the dow over the years. It would take mucho to get all that info.

[maxtower]

I have read that dividends account for half the stock markets return historically. Thats why today's yields of <2% are upsetting.

[DesertCat]

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I have read that dividends account for half the stock markets return historically. Thats why today's yields of <2% are upsetting.

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In the 1920s and 1930s the Dow averaged 5% dividend yields. In 1932 it's dividend yield was over 15%. Historical yields by decade are in "The Intelligent Investor". I am on the road so this is from memory.

Yields started to decline in the 1970s because dividends were triple taxed. Reagan fixed that but companies had discovered the benefits of stock buybacks. The biggest benefits of buybacks is for option holders who need price appreciation to get rich, I.e. management. Bush's dividend tax cuts makes dividends even more attractive but my guess is that mgmt will still favor buybacks and most future gains will have to come from price appreciation.

[DesertCat]

David,

I've read your response and believe I understand it fully, but let me point out that in no way does it directly rebut my points. If your scenario is true, then you should be able to describe why mine is false. Unfortunately the converse is not true, I can't yet rebut your scenario, and I will actually be working all week so I might not come up anything soon.

Is it time for a letter to Buffett?

[Mark1808]

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David,

I've read your response and believe I understand it fully, but let me point out that in no way does it directly rebut my points. If your scenario is true, then you should be able to describe why mine is false. Unfortunately the converse is not true, I can't yet rebut your scenario, and I will actually be working all week so I might not come up anything soon.

Is it time for a letter to Buffett?

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Dear Warren Buffett:

I know you have turned $100,000 in to $50 billion in the stock market. A guy who has written books on poker thinks he can improve on your methods. Basically if Martians had to bet on stock prices with a Warren Buffett Martian they couldn't do very well but if one of the Martians had contact with an earthling who knew the actual prices he could beat you. What do you think?

DC

Dear DC:

There are no Martians. Stock prices represent the collective vote as to the value of a company. I am good at determining when that vote does not accurately reflect what a knowledgable buyer would pay for a comapany as a whole. I stick to companies with a durable competitive advantage which means they grow earnings at consitant above average rates and are very unlikely to have nasty suprises in the future.

Can you ask David a question about poker for me? The average poker player loses money and Dave is a winning player. Sometimes Dave may advise a move that loses money, such as paying to draw to a flush at 8 - 1 when the flush doesn't hit. Since his advice is not perfect is there a way I can go counter to his advice when his advice differs dramatically from a random play and hence improve on his performance? For intance if a losing player always draws to a flush no matter what the odds, wouldn't a random pick as whether to draw be better than the average player? Since that random pick will sometimes do better than David's advice shouldn't I sometimes shade my move towards the random pick?

Warren

[Foghatlive]

I would think Martians are biased towards water companies.

[David Sklansky]

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David,

I've read your response and believe I understand it fully, but let me point out that in no way does it directly rebut my points. If your scenario is true, then you should be able to describe why mine is false. Unfortunately the converse is not true, I can't yet rebut your scenario, and I will actually be working all week so I might not come up anything soon.

Is it time for a letter to Buffett?

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If my scenario is true but still doesn't rebut the points you are trying to make, then I don't understand what those points are. In any case this discussion has drifted into an irrelevant area regarding randomness, neutral EV, etc. You appear to be confused about some of it but it is not worth getting into. It isn't the essence of what we wanted to ask Buffett about. (Said differently, it is the words below this paragraph that matter. It just so happens that those words, I contend, generally equate to "Even an expert should realize that his opinion when it differs from the market, will be wrong, on average. And the true value of the stock is between those two numbers." You are arguing that they don't equate. And you are wrong. But it is an irrelevant side issue.)

The important point is that it isn't only fulcrum stocks that are susceptible to information that routine, expert stock analysis, will mishandle. So it is valuable to to have a good idea why a stock's price is what it is. If the answer is simply "well the public usually values stocks in this industry, with this particular information, in about this way" you should be willing to bet on your disagreement if you have better insight than the public, even if your discrepancy with their price is fairly small. If you, on the other hand, think the price is screwy, you need a bigger discrepancy to bet.

However if you expected a big discrepancy and an unexpected price makes the discrepancy smaller, this is the best of both worlds. Don't pass on the bet just because the discrepancy fell below your normal threshold.

It is possible you can even make money taking this further by betting against your own opinion when you expected no discrpency and you find a moderate one you can't explain. That guess of mine Buffett need not know about.

Buffett would also be turned off by the idea that you can make money by isolating a particular aspect of a stock that you realize the public will misevaluate and making a bet without knowing anything else about the company. That method must win. But a non lazy approach would do better so he would be appalled by the lazier approach.

So please write the letter but don't mention the ideas in the two above paragraphs.

[Mark1808]

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David,

I've read your response and believe I understand it fully, but let me point out that in no way does it directly rebut my points. If your scenario is true, then you should be able to describe why mine is false. Unfortunately the converse is not true, I can't yet rebut your scenario, and I will actually be working all week so I might not come up anything soon.

Is it time for a letter to Buffett?

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If my scenario is true but doesn't rebut the points you are trying to make then I don't understand what those points are. In any case this disussion has drifted into an irrelevant area regarding randomness, neutral EV, etc. You appear to be confused about some of it but it is not worth getting into. It isn't the essence of what we wanted to ask Buffett about.

The important point is that it isn't only fulcrum stocks that are susceptible to information that routine, expert stock analysis, will mishandle. So it is valuable to to have a good idea why a stock's price is what it is. If the answer is simply "well the public usually values stocks in this industry, with this particular information, in about this way" you should be willing to bet on your disagreement if you have better insight than the public, even if your discrepancy with their price is fairly small. If you, on the other hand, think the price is screwy, you need a bigger discrepancy to bet.

However if you expected a big discrepancy and an unexpected price makes the discrepancy smaller, this is the best of both worlds. Don't pass on the bet just because the discrepancy fell below your normal threshold.

It is possible you can even make money taking this further by betting against your own opinion when you expected no discrpency and you find a moderate one you can't explain. That guess of mine Buffett need not know about.

Buffett would also be turned off by the idea that you can make money by isolating a particular aspect of a stock that you realize the public will misevaluate and making a bet without knowing anything else about the company. That method must win. But a non lazy approach would do better so he would be appalled by the lazier approach.

So please write the letter but don't mention the ideas in the two above paragraphs.

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http://www.sandmansplace.com/Mr_Market.html

Key quote:

But, like Cinderella at the ball, you must heed one warning or everything will turn into pumpkins and mice: Mr. Market is there to serve you, not to guide you. It is his pocketbook, not his wisdom, that you will find useful. If he shows up some day in a particularly foolish mood, you are free to either ignore him or to take advantage of him, but it will be disastrous if you fall under his influence. Indeed, if you aren't certain that you understand and can value your business far better than Mr. Market, you don't belong in the game. As they say in poker, "If you've been in the game 30 minutes and you don't know who the patsy is, you're the patsy."